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Cars are expensive these days. The average price for a new car was $ 66,807, according to AutoTrader.ca’s Price Index Report. According to the same report, used cars were also pretty costly, with an average price of $36,342.
Since most Canadians likely don’t have upwards of $30,000 on hand, it’s no surprise that many buyers borrow money to finance their new wheels. The two popular car financing options are a personal line of credit or a car loan. Either choice gets you your new ride, but which is the best for you?
The terms and conditions of auto financing can be confusing, and it’s risky to sign on the dotted line without fully understanding what you’ve agreed to. But the details matter when you’re spending tens of thousands of dollars (or more) on your new ride. A car loan or a line of credit can impact your monthly budget, long-term financial goals and overall debt load.
In this brief guide, we’ll explain the key differences between a personal line of credit and a car loan to help you decide which best suits your needs.
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What Is a Personal Line of Credit?
A personal line of credit is a type of loan that works similarly to a credit card in that it’s revolving but typically has a lower interest rate. You can borrow and repay funds on an ongoing basis, within a predetermined limit set by a lender. You only pay interest on the amount you borrow, and once that’s repaid, the money is free for you to use once more.
Pros and Cons of Personal Line of Credit
Pros:
- Flexible: You can borrow as much or as little as you need, up to your credit limit, and only pay interest on the amount you borrow.
- Ongoing access: You can continue to use a line of credit as long as you make payments and stay within your credit limit.
- No collateral: Most personal lines of credit are unsecured, which means a lender can’t take your home, car or other asset if you’re unable to pay it back.
Cons:
- Interest rates vary: Interest rates on a personal line of credit are typically variable, which means they can go up or down depending on the policy rate set by the Bank of Canada.
- Higher interest rates: Personal lines of credit may have higher interest rates than car loans because they are unsecured.
- Debt risk: Since you can keep borrowing and repaying a personal line of credit, it is easy to keep accumulating more debt.
What Is a Car Loan?
A car loan is a type of installment loan designed for purchasing a vehicle. The loan is repaid over a set period of time, typically between 12 and 96 months. If you can’t repay the loan, the lender can repossess your car. It’s considered a secured loan because it’s “secured” by your car.
Pros and Cons of a Car Loan
Pros:
- Predictable payments: Most car loans have a fixed rate, which means their interest payments don’t change. This makes budgeting easier and ensures the loan will be paid off in a specific timeframe. While variable-rate car loans are available in Canada, they are relatively uncommon.
- Lower interest rates: Interest rates on a car loan are often lower than those of a personal line of credit because a car loan is secured by your vehicle. As of June 2024, the average auto loan interest rate in Canada was 7.59%, whereas the average rate on an unsecured line of credit was 10.35%, according to StatCan.
- Easier to qualify: Car loans are generally easier for those with less-than-perfect credit to obtain, as the vehicle serves as collateral. Some lenders even allow borrowers with no credit history to apply for a car loan, although they might impose additional restrictions on these loans.
Cons:
- Less flexibility: A car loan is for a specific vehicle purchase, and you can’t use the loan for anything else. If you’re looking for extra money to cover the cost of repairs or even a second vehicle, you’ll need to apply for a new loan.
- Potential for negative equity: Negative equity occurs when the value of your car drops faster than you can pay off the loan. If you try to sell or trade in the vehicle, you might still owe money on the loan even after the sale, leaving you on the hook for the remaining balance.
- Risk of repossession: If you default on payments, the lender can repossess your car.
- May require a down payment: Some lenders require a down payment, which can be a barrier for some buyers.
Personal Line of Credit Vs. Car Loan: Differences
On the surface, a car loan and a personal line of credit seem to have more similarities than differences. Both loans charge interest, require regular payments and are used for expensive purchases. However, if you look under the hood, you’ll find some significant differences.
Choosing between a car loan and a line of credit can have long-lasting implications for your financial health.
Let’s break down the key differences:
Which Is Right for You: Car Loan or Line of Credit?
Consider the following factors when deciding between a car loan and a line of credit:
- Credit score: Your credit score significantly impacts your options. If you have excellent credit (typically 750+), you’ll almost certainly qualify for better rates on a line of credit. However, if your credit is fair (below 670) or poor (below 580), a car loan might be a more viable option for you. Some lenders might not consider you for a personal line of credit, but there are plenty of car loan options for borrowers with low credit scores. Remember that while these subprime car loans provide an opportunity to finance a vehicle, they often come with higher interest rates and less favourable terms.
- Vehicle value: The price of the car you’re purchasing plays a crucial role. A car loan will offer better rates and terms for new or pricey used vehicles because they are more valuable as collateral. A line of credit can be more convenient for less expensive or cheaper used cars because it offers flexible borrowing and repayment terms. You only borrow what you need, and since it’s already set up, you can access the funds quickly without applying for a separate loan.
- Financial discipline: Be honest about your spending habits. If you struggle with credit card debt or tend to overspend, a car loan with fixed payments will provide a safer, more structured approach. A line of credit can work well if you’re disciplined with credit and prefer more control over your repayment schedule.
- Flexibility needs: Consider your overall financial needs. A line of credit offers the versatility to borrow for multiple purposes, which is ideal if you anticipate other expenses. On the other hand, a car loan is solely for a vehicle purchase, which keeps your car financing separate from your other finances. This makes it easier to track how much you owe on your car without it being mixed with other purchases or debts, which can happen with a line of credit being used for multiple purposes.
- Interest rate preferences: Choose a car loan if you prioritize predictable payments. These typically come with fixed rates, ensuring your monthly payment remains constant. Lines of credit usually have variable interest rates, which could affect your monthly payments.
- Down payment availability: If you can make a substantial down payment (20% or more), your car loan payments will decrease substantially. (Keep in mind some lenders require down payments, specifically for expensive vehicles or borrowers with bad credit.) With a line of credit, your existing limit and rates typically don’t change based on a down payment, which might be preferable if you want to keep more cash on hand.
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Frequently Asked Questions (FAQs)
What is the difference between a line of credit and a car loan?
The main differences are in their structure and purpose. A line of credit can be used for various purposes, including buying a car. You can borrow and repay funds as needed, up to your credit limit. A car loan, on the other hand, is a loan specifically for purchasing a vehicle that usually involves set monthly payments over a defined term.
Can a line of credit be used for a car?
Yes, a line of credit can be used to purchase a car. It offers flexibility in terms of how much you borrow and how you repay it. However, it’s important to consider factors such as interest rates, your financial discipline and long-term costs when deciding whether to use a line of credit instead of a traditional car loan for your vehicle purchase.
What is the average interest rate on a car loan?
As of June 2024, the average auto loan interest rate in Canada was 7.59%, according to StatCan.
What is the average interest rate on a line of credit?
As of June 2024, the average rate on an unsecured line of credit was 10.35%, according to StatCan.